Bumpy ride ahead for Golden (green) State in energy transition

Los Angeles, California, USA - June 21, 2017: Road and shops at Venice Beach, Los Angeles, California.
Los Angeles, California, USA - June 21, 2017: Road and shops at Venice Beach, Los Angeles, California.
Opinion by Michael Ferguson

Michael Ferguson, director, Sustainable Finance, S&P Global Ratings explores the potentially bumpy ride ahead as California sets out on its road to a 100% renewable energy grid

The U.S.’ Golden State is perhaps the greenest, too: California’s governor, Jerry Brown, recently unveiled landmark legislation requiring the state to derive all its power from renewable energy sources by 2045. However, amid federal backsliding on environmental progress, under the leadership of a president that has been described as a “champion of coal”, California has taken back the reins – becoming the curator of a new gold standard for renewable energy proliferation in the U.S.

Yet for all the legislation’s praise, even the most vocal supporters of Brown’s mandate acknowledge the extent of the challenges ahead. First, renewable sources produce about 35% of the state’s energy today. Though this is comparatively high against other states, it demonstrates the scale of the task at hand. Then, for the most part, renewables are an intermittent energy source, which poses reliability concerns. And surmounting these hurdles will rely on substantial technological improvements that are yet to materialise.

Fossil fuels: end of the road

By some, California’s new law is considered merely the ultimate codification of an already well-established trend towards renewable energy. In the past decade, all of the state’s coal-fired generation has been closed, while its final nuclear power plant, Diablo Canyon, is scheduled to be decommissioned in 2024.

Similarly, gas-fired generation, which currently contributes around 33% of the state’s power, looks set to follow a course to decline; in some ways, gas could be the new coal in California. Indeed, market consensus suggests that, politics aside, the economics for new gas-fired capacity are becoming impractical, especially when considered over the entirety of the asset’s life. That said, in the near term it is likely that gas-fired generation could see some benefit in its role of supporting the grid during its pending transition, serving to fill in the gaps that renewable generation’s intermittency leaves before batteries fully come of age. Crucially, though, the extent of this benefit will, given the nature of the law, prove finite.

Road to renewable

While the grass is greener for the renewable energy sector, the resultant advantage may vary between asset types.

For instance, wind and solar pose by far the largest conundrum: can these sources overcome reliability concerns? Both solar and wind are intermittent energy types: only “plus storage” solutions would allow them to consistently supply the grid. Therefore, replacing the incumbent grid with 100% renewables could, according to some estimates, necessitate a 200-fold increase in battery storage across the state over current levels. And, at present, it is unclear whether the rate of technological development in this field is enough to keep pace during the next decade, especially as renewables, on a standalone basis, become more economical. Storage solutions, for instance, currently struggle with energy loss and “depth” of charge. Absent technological improvements, an over-capacity of solar and wind sources would be required to ensure reliability.

Arguably, best placed to benefit are California’s hydro and geothermal assets. Both asset types have much lower resource risk and are, crucially, closer to baseload. This helps solve a critical problem: meeting the ambitious mandate while also securing energy reliability. Further, hydro and geothermal generators typically have longer asset lives compared to the 20 or 25-year lifespans of solar and wind assets.

On the downside, building new hydro or geothermal assets are time- and capital-intensive. The building process, too, when compared to solar assets, is environmentally far more disruptive. Given this, it is likely that proliferation will remain somewhat prohibited, barring any large unforeseen state incentives, but the existing fleet is likely to benefit from favourable pricing when contracts are renewed.

Paying for it all

Then comes the final conundrum: who pays? California’s lofty ambitions will likely require an equally significant pay-check – bringing into focus the existing debt funding structures available.

Partly thanks to California’s cemented role as a renewables leader, utility scale solar and wind projects should face few financing roadblocks. But for the overarching goal to be met, nascent industries, such as distribution generation, and battery storage, are likely to each play a vital role. Yet, at present there has been little consensus on how these assets will be financed; we do, however, anticipate that California’s strategies for reducing gross power demand will help mitigate this risk to a degree.

One option, which California is keen to support, is green financing. In an increasingly aware investment and consumption market, issuers are beginning to acknowledge the importance of bolstering their “green” credentials. Though evidence of pricing advantage remains limited, the reputational gains are clear. Thus, it seems likely that the green bond market will play a vital role – transforming and broadening in order to reach California’s green destination.

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